The Political Economy of Trade Policy: A Short Survey

Transcription

1 The Political Economy of Trade Policy: A Short Survey Douglas R. Nelson Murphy Instititute, Tulane University & Leverhulme Centre for Research on Globalisation and Economic Policy, University of Nottingham January 7, 2007 Draft. Prepared for the Princeton Encyclopedia of the World Economy. 1

2 After the provision of internal order and external security (and bound up with both as a source of revenue), the regulation of international trade is one of the oldest known activities undertaken by states. Thus, it is not surprising that we have records of analytical comment on commercial policy over essentially the entire period that we have identi ably economic and politicaleconomic writing. Most of this early writing is political economy in the sense of practical policy advice but this is not unrelated to its more modern meaning as positive accounts of policy choice. Policy advice is given under an implicit assumption that the government is willing and able to act on such advice. Such a Weberian model, however, is exceptionally uncommon in contemporary political economy research [even when, as in the case of very low levels of protection, it would seem to be a more accurate model than the obvious alternatives]. Instead, we take the obvious fact that trade policy deviates from virtually any straightforward model of welfare maximization as a warrant to consider alternative accounts of policy determination. The great majority of this work begins with an attempt to link policy preferences of the relevant agents to their material self-interests de ned in terms of the primitives of some underlying model of the economy, and then seeks to map these policy preferences into policy outcomes via some (usually extremely spare) model of policy determination. 1 Early Steps in the Political-Economy Analysis of Trade Policy The most immediate predecessors of modern research on the political economy of trade policy are three works by political scientists that still repay close study and that contain most of the themes that still motivate contemporary research: Schattschneider s (1935) Politics, Pressure and the Tari ; Bauer, Pool and Dexter s (1963) American Business and Public Policy; and Lowi s (1964) American Business, Public Policy, Case Studies, and Political The- 2

3 ory. The rst of these treats trade policy (in this case the Hawley-Smoot tari ) as the outcome of an asymmetric lobbying process in which protection seekers dominate and certain sectors are more e ective than others. Bauer, Pool and Dexter saw their work as a rejection of Schattschneider s. Looking at omnibus trade legislation in the period , they found (among other things) members of Congress relatively free from lobbying constraint and saw lobbying primarily as information transmission. Lowi s brilliant review and reconciliation argued that a fundamental institutional change had resulted in a rede nition of trade policy such that the politics had changed between the periods studied in these two classic works. Although the great bulk contemporary research on the political economy of trade is rooted in the asymmetric group theoretic tradition presented in Lowi, a growing body of work emphasizes institutional features and, while not much applied to trade policy, the dominant strand of research on lobbying in political science now emphasizes informational issues (see Austen-Smith, 1996, for a convenient review). The rst wave of research by economists on the political economy of protection was actually less concerned with developing a coherent and, at least in principle, testable positive theory but rather with nding a way to increase the costs of protection. In the rst paper of this sort, Tullock (1967) argued that the triangles of welfare analysis were sizable underestimates of the actual welfare costs of protection (and monopolies). Speci cally, potentially productive resources were spent seeking the rents implied by the presence of the tari. Accounting for these would permit us to could count the rectangle, as well as the deadweight loss triangles, as costs. The empirical application of this logic by Krueger (1974) to the case of Turkey, a case in which rent-seeking clearly added to the costs of protection moved political economy analysis to the center of trade policy analysis, at least in developing countries. This approach reached its most sophisticated form in the work of Bhagwati and his coauthors on directly unproductive pro t- 3

4 seeking activities (e.g. Bhagwati, 1982; Bhagwati and Srinivasan, 1980). As applied to pathological situations (e.g. Turkey) this approach makes a lot of sense, but as a general extension of the normative analysis of trade policy it is deeply problematic: adding the economic costs of political action to the costs of protection, without a systematic normative analysis of political action makes little sense. After all, in a non-pathological situation, lobbying or directly unproductive political activities are just other terms for citizens approaching their government. The ability of citizens to do this is an essential component of democratic political process, something most of us would consider highly positive. The other precursor to current work grows out of Olson s (1965) Logic of Collective Action and the closely related earlier work by political scientists on the foundations of group theoretic models of political action. Beginning with papers by Fielke (1976) and Caves (1976), a large number of papers were published which sought to account for tari structure in terms of a number of, more-or-less ad hoc, variables in a linear regression framework. 1 Sign patterns in these variables were suggested in terms of a number of loose explanatory frameworks. This work increasingly focused on variables seen to be associated with e ective group formation and then used loosely construed models linked to early Chicago school political economy as an interpretive framework. Early work by Ray (1981a; 1981b), Dougan (1885), Godek (1985), and the World Bank project summarized in Anderson and Baldwin (1987) are characteristic; and this body of work reaches its most sophisticated form in work by Tre er (1993), Lee and Swagel (1997), and Gawande (1997; 1998). Overall, this work provides quite strong evidence that political economic factors must be part of any coherent account of systematic patterns in the tari structure 1 Caves used the labels: the adding machine model (essentially re-election maximization); the interest group model (Olsonian collective action); the national policy model (Weberian optimal policy). Caves ultimately concludes that the interest group model receives the strongest support. 4

5 2 Political Preference and Minimally Institutional Political Economy The core of virtually all political economy models developed by economists is a formal derivation of preferences over policy from primitives of the underlying model of the economy. More formally, endogenous policy models build some form of explicit political structure into some form of neoclassical general equilibrium model. That is, the underlying economy is made up of households, characterized by preferences over nal goods and portfolios of productive factors, and rms, which transform factors of production into - nal goods. We can denote a neoclassical economy: E = {Z, F, R}, where Z is a matrix allocating factors of production among households, F a vector of technologies, and R a vector of household preferences over nal commodities. To this economy we attach a vector of possible interventions (t) and a political mechanism (M) yielding a political-economy: P = {Z, F, R; t, M}. The easiest part of the analysis of a system like P involves the derivation of citizen preferences over policy. For a given household, h (R h 2 R, z h 2 Z), for a xed E, we simply ask how any relevant state of the policy variable (t) a ects household welfare. By answering this question for every feasible state of the policy variable, we trace out household political preferences over that policy. It is now well-known that the general Arrow-Debreu model does not yield comparative static results of the sort necessary for this exercise (see section 17.E in Mas-Colell, Whinston and Green, 1995). As a result, most work in this area builds on either a Heckscher-Ohlin-Samuelson model (i.e. a model in which all factors are fully mobile between sectors) or a Ricardo-Viner model (i.e. a model in which every sector is characterized by a speci c-factor and a single mobile factor is used by all sectors). The former yields con ict based on factor-ownership (i.e. class con ict), while the latter yields con ict based on industry attachment. Recently, a specialized form of the latter 5

6 has been widely used (Grossman and Helpman, 1994), in which n-1 sectors are characterized by a speci c factors structure and the n th sector (the numeraire sector) is a freely trade Ricardian good. This is usually combined with quasi-linear preferences to produce an economy in which virtually all general equilibrium linkages have been severed. This makes for an extremely tractable, if somewhat implausible, framework for political economy modeling of contemporary trade policy. 2 If we think of the Heckscher-Ohlin-Samuelson model (and its dimensional generalizations) as a model of the long-run and the Ricardo-Viner model as representing a relatively short-run, it is probably clearest to treat their use in political economy models as re ecting the period of political calculation. That is, if political agents make their calculations over a relatively short time period, the most appropriate model would be some form of speci c-factors model; while, if the time horizon of political calculation is long, the HOS model is more appropriate. 3 The evidence is somewhat mixed, but the bulk of it would seem to suggest that, for most agents, the time horizon of political calculation is relatively short. 4 2 Schattscheider s description of tari making as what Lowi called "distributive politics" suggests that a model of this sort might well be appropriate in that case. Contemporary (GATT/WTO-legal) protection emerges from a two-stage process in which rules of general application are set in the rst stage which are then administered by a bureaucracy. If participants focus on the general rules they cannot possibly ignore broad general equilibrium e ects, but if they focus on the administered mechanism they cannot possibly care about anything but partial equilibrium e ects. In either case, the model seems inappropriate to the politics of trade policy as actually practiced. 3 We would generally expect time horizon of political calculation to be linked to material conditions of factor mobility and underlying economic conditions. See Hall and Nelson (1989) for a general argument about factor mobility and institutions in determining the orientation of political activity, and Hiscox (2001) for an impressive theoretical and empirical attempt to link political behavior exclusively to the material conditions of factor mobility. 4 The most compelling evidence comes from actual political activity. Starting with Magee s (1978) classic study of testimony on trade legislation most work has found strong evidence of sector-based political activity. This is consistent with studies of capital and labor mobility that suggest relative immobility over politically plausible time horizons (i.e. 2-6 years in the U.S.). Research on policy preferences revealed by public opinion polls is generally interpreted as more consistent with factor-based calculation (e.g. Scheve and Slaughter, 2001), however recent work by Hainmueller and Hiscox (2006) suggests that this 6

7 Just as knowing preferences over nal goods is not su cient for a theory of market equilibrium, knowledge of political preferences is not su cient to determine political-economic equilibrium. In principle, a model of political action must be combined with a model of policy determination to determine a full political economic equilibrium. Here there are many possibilities. One convenient way of distinguishing the basic models is in terms of what is assumed about the activity permitted of demanders of policy and suppliers of policy. If we consider that each type of agent (demander and supplier) may be active or passive, we get the simple typology shown in table 1. 5 Passive Groups Are: Active State Passive Referendum t Formation func. is: Active Pol.Resp.Func. Menu auction The simplest approach is to assume that policy is determined by a referendum on the tari. Under the assumption that voting is costless (and the assumption that preferences are single-peaked over a one dimensional t), this approach simply determines the policy outcome at the most preferred point of the median voter. No resources are used up in the political process, there are no gains from misrepresentation of preferences, so once citizen policy preferences have been determined, the step to nal policy determination is trivial (Mayer, 1984). The virtue of this approach is its simplicity, but it has at least two major drawbacks as a framework for empirical work: there have been almost no actual referenda on trade policy; and, at the level for conclusion may be based on an incorrect inference from the data. All of this work presumes that policy preferences are relatively xed. However, while is an essential support of political economy modeling, Hall and Nelson (2004) nd that aggregate preferences over NAFTA were far from stable. 5 There are now something like 20 reviews of various aspects of the literature on the political economy of trade. Two current reviews are particularly relevant from the point of view of this article. Helpman (1997) provides a very useful overview of the various models mentioned in table 1 in the context of a common model of the economy. Gawande and Krishna (2003) provides a useful and up to date survey of empirical work. 7

8 which general equilibrium analysis is appropriate, trade policy is inherently multidimensional. 6 As a public issue, trade policy usually is discussed in terms of the overall level of protection o ered in the country as a whole (not in terms of tari s on speci c line items in a tari schedule). Seen in this way, there have been times and places in which "The Tari " was su ciently important to public partisan competition that a given election could be seen as a referendum on the tari. 7 An extension of this approach implicitly assumes that representatives are elected to represent their constituencies on trade policy, so that their votes on trade policy can be treated as determined by the material interests of their constituents. 8 However, as Bauer, Pool and Dexter (1963) argued, and as implied by theoretical work on voting in high dimensional issue spaces (e.g. Plott, 1967; McKelvey, 1976), given the dimensionality and complexity of the issue environment in which representatives operate, they will generally be free to vote on virtually any issue as they prefer. Thus, especially for issues, like trade, which are not major reelection issues, inference based on this constraint seems less than well grounded. Given that, at least until recently, trade policy has not been a major public issue, some form of lobbying model would seem to be a more solid basis for framing the analysis of the political 6 The unique exception to both of these are a pair of Swiss referenda on two speci c lineitems in the Swiss tari (processed food in 1975 and sugar in 1986). See Weck-Hannemann (1990) for a discussion of this episode. 7 Examples include the Canadian election of 1911 (Johnston and Percy, 1980; Beaulieu and Emery, 2001), and the British elections of 1906 (Irwin, 1994) and 1911 (Irwin, 1996). This work provides plausible accounts of tari policy determination in terms of a straightforward referendum model. 8 A sizable empirical literature proceeds, more and less explicitly, on this assumption. The classic of the form is Baldwin (1976; 1985), but the list is long. Recent examples include Hiscox (2002), Fordham and McKeown (2003), and Ladewig (2006). Some work treats the material link as unproblematic and uses deviating votes as evidence of "ideological voting" (e.g. McCarthur and Marks, 1988). However, Go and Grier (1993) identify a fundamental problem with this inference, even in the context of voting that is actually constrained by constituent interest. New techniques to deal with this problem have been developed by Levitt (1996) and Heckman and Snyder (1997), and applied to voting on trade by Bohara and Gawande (2004). 8

9 economy of trade policy. The simplest approach is to follow Stigler (1971) and Peltzman (1976) in doing away with the attempt to model demanders and focusing on the behavior of suppliers who face an untheorized (but completely plausible) function of implicit group demands and a concern with the general welfare consequences of their actions (Hillman, 1982). The political support function re ects the trade-o facing a politician who seeks to favor one group (say, producers) at the expense of another (consumers). While Peltzman (1976) and Hillman (1982) motivate their analysis by loose reference to lobbying in the context an election constraint, neither the lobbying nor electoral competition are explicitly modeled. The general pattern of signs could emerge from a variety of institutional environments. Thus, it seems sensible to characterize this approach as "active state/passive groups". The essentially ad hoc form of the political support function makes for a natural match with the ad hoc empirical analysis referred to in the previous section. 9 Where the political support function approach abstracts from the political activity of groups, lobbying models, with a passive register state, introduce an explicit analysis of costs of political action and rational strategic behavior by groups, but abstract from active decision-making by the state (e.g. Findlay and Wellisz, 1982; Young, 1982). The core institutional assumptions of this model are: 1) e ective political demand is represented by the lobbying activity of entrepreneurial political action committees; 2) political activity involves no xed costs and there are no collective action problems in the organization of group activity; and 3) the state is a passive register of e ective citizen demand. That is, politically active sectors hire labor to engage in lobbying and the state is represented by what Helpman (1997) calls a tari -formation function: t = (L), where L = fl 1 ; :::; L n g is a vector of 9 In fact, the work of Dougan (1885) and Godek (1985) explicitly uses the Petlzman- Hillman framework to motivate their analysis. One of the most interesting analyses of this sort is Tyers s (1990) application of Gardner s (1983) surplus transformation curve method to the political economy of trade liberalization. 9

10 quantities of labor hired for lobbying. The outcome is determined as the Nash equilibrium in lobbying, where PACs take into account the direct cost of lobbying (i.e. wl i ), the indirect costs (i.e. the e ect on the market wage of withdrawing labor from production for use in lobbying), and the return on lobbying via (L). A major advance in the formal theory of lobbying was made by Grossman and Helpman (1994), who developed a model in which the state and economic agents are politically active, thus rendering both the political support function and the tari formation function approaches essentially irrelevant (see also Dixit, Grossman and Helpman, 1997). Grossman and Helpman s essential insight was that the relationship between lobby groups and the state could be e ectively modeled as one of common agency and that Bernheim and Whinston s (1986) menu auction model of common agency was a perfect framework for developing a broader model of political economic equilibrium than had previously been presented. Each active PAC o ers the state a menu associating a payment with every possible tari schedule and the state then chooses a tari schedule that maximizes it s welfare. Unlike the passive register state, the Grossman-Helpman state is explicitly concerned with overall welfare as well as bribes. 10 Speci cally, their state s objective function is a linear combination of bribes and aggregate welfare: G = P C i (p) + aw (p), i2i where the C i are the bribes ("contributions"), the W is aggregate welfare, both are conditional on the state s choice of p (the price vector determined via the small country assumption by the tari ), and a is the weight the government attaches to aggregate welfare. Note how this structure embeds both the Weberian state and the passive register state as special cases. Given the menu auction structure as a characterization of politics, and the claim that truthful equilibria are focal among the continuum of equilibria 10 Like papers using a political support function, papers using the menu auction approach often use the language of "campaign contributions" and "elections", but none of this is essential. Bribes are surely taken in political systems that are non-democratic, and even dictators may be concerned with levels of overall welfare. 10

11 that generally result, and the Grossman-Helpman economy characterized by quasi-linear preferences, n-1 sectors characterized by a speci c factors structure and a freely traded Ricardian numeraire sector, Grossman and Helpman show (proposition 2) that equilibrium trade taxes and subsidies must satisfy a modi ed Ramsey rule: t i 1 + t i = I i L a + L where I i is an indicator variable that takes a value of one if the sector is organized and zero otherwise, L is the fraction of the total population that is organized by some lobby, z i is the ratio of domestic output to imports, and e i is the elasticity of import demand. This form has been widely taken z i to be a framework for structural estimation. e i ; Overall, there seems to be considerable econometric support for lobbying as a key determinant of the cross-section pattern of protection. 11 For all the success of the basic models reviewed in this section, primarily in providing a general account of deviations from welfare optimal policies in terms of political pressure and in providing a speci c account of the crosssectional pattern of protection, it is hard to escape the conclusion that, more than other branches of research on political economy (in particular, local public nance and macroeconomic policy), the gap between the models and their object (either as formal empirics or as a framework for understanding) is large. The next section considers several avenues of current research that seek to extend the scope of research on the political economy of protection, but we conclude this section with one problem fundamental to lobbying 11 Early papers by Goldberg and Maggi (1999) and Bandyopadhyay and Gawande (2000) set an early standard that has been followed by a large number of papers (e.g. Eicher and Osang, 2002; McCalman, 2004; Cadot, de Melo and Olarreaga, 2004; Matschke and Sherlund, 2006; Lopez and Matschke, 2006; Gawande and Hoekman, 2006). In addition, another sizable body of work has included lobbying variables (mainly campaign contribution data) in otherwise standard ad hoc analyses of cross-section patterns of protection (e.g. Nollen and Quinn, 1994; Baldwin and Magee, 2000; Magee, 2002; Fordham and McKeown, 2003; Hiscox, 2004; Drope and Hansen, 2004). 11

12 models: exogeneity of group organization. All of the research on lobbying we have considered to this point treats group organization as exogenous: there is no formal analysis of groups at all in the political response function literature; tari formation function and menu auction models treat active groups as fully organized and completely e cient in extracting resources to pursue political goals (the menu auction models explicitly treat organization as primitive re ected in I i in the modi ed Ramsey rule). This was a sensible strategy in the early development of lobbying models, but before they can be treated seriously as frameworks for empirical analysis group formation needs to be systematically integrated into the analysis. 12 The few attempts that have been made to construct such an analysis build, sensibly, on Olson s (1965) theory of collective action. Two approaches seem to have been pursued, both of which treat lobbying as an example of voluntary provision of a collective good. The approach that matches the lobbying models most directly focuses on the decision to join under the assumption that agents joining a PAC will be taxed optimally by the PAC organizer (Chiu, 1998; Mitra, 1999). While this is a good match to the theory of lobbying, it is a poor match to the empirical reality in which groups seem not to be either perfectly organized or perfectly unorganized, but rather to be more-or-less well organized. 13 The alternative is to assume that all groups are potentially active and consider contributions from zero to some maximal (or optimal) level. While there is no shortage of work that considers contributions to a single lobby (treated as a public good), there is very little work that considers those contributions in a strategic context (e.g. 12 This critique obviously does not apply to referendum models. This would seem to be the explanation for the considerably greater empirical success of political economic analysis of local public nance (where there really are referenda on the objects of analysis, e.g. school bonds) or macroeconomic policy (where national elections can be reasonably seen as referenda on macroeconomic policy). Unfortunately, trade has not really been a major electoral issue since the early 1930s. 13 It is interesting that the standard approach to empirics of the Grossman-Helpman model involves dividing groups that appear to be di erentially organized into the binary category by some more or less arbitrary method. 12

13 Chater 6 of Magee, Brock and Young, 1989). The problem with this latter approach is that "groups" are not really organized, but simply exist as a function of a common pattern of individual contributions. One of the early fundamental criticisms of Olson s work was the lack of attention to political entrepreneurship in the formation of groups and it seems like an explicit introduction of political entrepreneurs might be a route to linking these two approaches. 3 Frontiers of Research on the Political Economy of Protection The essentially context free theoretical environment of the models we have considered to this point is a feature, not a bug. As with virtually all good modeling programmes, the endogenous policy approach to political economy modeling achieves its cutting power by abstracting from details that interfere with the main line of the story in this case, the contest of material selfinterest projected from the economy to the political system. Models serve a number of purposes: 1. Cautionary tales: most people think X, but in my model not X; 2. Just So stories: here is a fact, I can construct a model rationalizing that fact; 3. Loose frameworks for thinking about issues; and 4. Generators of structural frameworks for econometric analysis. The Tullock-Krueger-Bhagwati work discussed in the rst section was essentially of the rst sort (protection is more costly than you might think as a result of rent-seeking costs), most of the work discussed in the second section is of the second and third sort (it is plausible to think about "bad policy" as 13

14 the outcome of a political process and the empirical work is loosely consistent with those accounts). Grossman and Helpman s modi ed Ramsey rule has been treated as a structural form, but the results of that work do little more than underwrite the use of the model for purposes 2 and 3. Making these models more operationally relevant means introducing more of the relevant context into the models. 14 economic context. Current work focuses on both political and In terms of political context, one approach that is receiving attention is the attempt to explicitly model the link between contributions, elections and policy outcomes (rather than burying the link in a political response function or the government s objective function). 15 The focus on the role of partisan competition opens the door to both theoretical and empirical work of a comparative nature (e.g. McGillivray, 2004; Grossman and Helpman, 2005), as well as cross-sectional work on the foundations of partisan support (e.g. Keech and Pak, 1995; Epstein and O Halloran, 1996; Hansen and Prusa, 1997; Bohara, Camargo, Grijalva and Gawande, 2005). This work is interesting, but given that protection is now rarely set by legislatures, it seems unlikely that this line of work will be much help in extending the applicability of current models. By contrast, the sizable body of work that builds on detailed knowledge of the GATT/WTO-legal administered protection mechanisms has already begun to provide a rich body of theoretical and empirical work consistent with the more general models discussed above (Blonigen and Prusa, 2003; Nelson, 2006). 14 Note: I am not arguing that models must somehow approach "reality" to be useful. Quite the contrary (reality is its only complete model), to be useful models must abstract from reality. The question at issue is: which simplifcations can be sensibly relaxed to produce more useful results? 15 It is interesting to note that the rst serious attempt at positive modeling of the political economy of trade policy by economists was of this sort (Magee, Brock and Young, 1989). The apparent complexity, as well as some analytical and interpretive problems, resulted in initially low impact (Austen-Smith, 1991). Recent research has built on the probabilistic voting model to provide clear foundations for such models (Mayer, 1993; Mayer and Li, 1994; Clark and Thomas, 1995; Yang, 1995; Mayer, 1998). 14

15 An alternative direction of generalization abstracts from the assumption that markets are complete and perfect. One of the standard results of time series work on the correlates of protection is that demand for protection, and protectionist outcomes, are positively related to unemployment. This is loosely consistent with public opinion data suggesting that support for protection increases if questions are "framed" in terms of unemployment (Hiscox, 2006). This suggests that modeling the economy, on which the political economy is based, as characterized by equilibrium involuntary unemployment, could make a major contribution to our understanding of the political economy of trade policy. Recent work by Bradford (2003; 2006) and Matschke and Sherlund (2006) make a start in this direction, but there is room for much more. Similarly, standard models assume that political preferences are strictly self-regarding. However, experimental results and public opinion data suggest that political preferences are more complex. In particular, it seems clear that widely held notions of fairness strongly a ect expressed preferences over trade policy. To the extent that public politics constrain trade policy, it would seem to be important to try to incorporate such considerations in our models (Davidson, Matusz and Nelson, 2006). 4 Conclusion: Thinking about Good Trade Policy Virtually all of the work we have considered to this point has attempted to account for bad (i.e. welfare reducing) trade policy. Given that the single most important fact of trade policy in the era since the Second World War is the historically striking trend toward greater trade liberalism and, by the mid-1980s, the truly extraordinary low level of overall protection in the world s major trading nations, this focus seems a bit peculiar. If we believe, as surely we must, that political economy forces help explain the structure of protection, it seems equally clear that political economy forces must help 15

16 explain this Liberality. These forces need not be the same and, in fact, are unlikely to be the same. Thus, the gains from new work on the domestic political economy of liberalization would seem to be sizable. One approach to this question might be to study the link between liberalization and protection. Whereas in the era of tari politics liberalization and protection were simply directions in a relatively unidimensional scale, in an era in which omnibus trade legislation endorses the power to liberalize at the same time it changes the terms of administered protection, it is not only di cult to say whether a piece of such legislation is protectionist or liberalizing, it seems likely that the two are related. 16

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